Originally published in the July 25 edition of World Tax Daily (Copyrights Tax Analysts – www.taxanalysts.com)
Brazil’s President Luiz Inácio Lula da Silva has signed Law 11,508/07, which changes the tax regime applicable to the country’s special export processing zones (ZPEs) — but first he vetoed 19 articles, upsetting supporters of the original law project and also Argentina, which is a trade partner in Mercosur, a common marker created by Argentina, Brazil, Paraguay, and Uruguay.
Law 11,508/07, published in the official gazette on July 23, is the result of Project 146/96, approved by Brazil’s Senate on June 27. The law empowers the executive branch to create ZPEs in less developed regions of the country with the goal of reducing regional differences and promoting exports and social and economic development. As signed by Lula da Silva, however, the law no longer contains the tax incentives that made ZPEs attractive.
The most important provision vetoed by Lula da Silva granted tax incentives for imports and exports of goods and services to and from ZPEs. Article 10 granted exemptions from import tax, the federal excise tax (IPI), P.I.S. (the Program for Social Integration contribution), COFINS (the Contribution for the Financing of Social Security), the additional tax on freight, and the financial transactions tax. In practical terms, ZPE companies no longer will be eligible for any tax breaks on their imports, which virtually eliminates all of the ZPEs’ original advantages. The executive branch is considering a provisional measure that would restore, at least partially, some of the vetoed tax incentives, though it is not clear yet which of the incentives would be restored and to what extent.
In his message on the veto of article 10, the president argued that because ZPE companies will be able to sell as much as 20 percent of their production in domestic markets (a concession that was not vetoed), retaining the tax incentives on imports would harm competition between ZPE and non-ZPE companies.
Another important veto eliminated a full corporate income tax exemption originally in Project 146/96 that would have been effective for 5 or 10 years, depending on the location of the ZPE. The same veto eliminated a general withholding tax exemption applicable to any type of payment abroad by a ZPE company. Lula da Silva said the withholding tax exemption was nothing more than a transfer of taxation to the home country of the foreign beneficiary of those payments.
Lula da Silva also vetoed a tax break related to sales by Brazilian suppliers of goods, including natural gas and electricity, to ZPE companies. Under article 19 of Project 146/96, sales to ZPE companies were eligible for the same tax breaks applicable to exports — that is, exemptions from P.I.S., COFINS, and IPI. With the veto of article 19, sales to ZPE companies no longer receive tax treatment equivalent to exports, but rather are treated as domestic sales, with no tax break whatsoever. Once again, the president reasoned that no tax distinction should exist between sales to ZPE companies and sales to non-ZPE local manufacturers. A similar provision regarding sales of services to ZPE companies was vetoed, so the provision of services to SPE companies is also taxed the same as any other service rendered locally.
Also vetoed was a questionable tax break under which nonresident individuals working for ZPE companies were not required to contribute to Brazil’s social security system as long as they waived any right to claim social security benefits in Brazil. The president argued that such tax relief would be unconstitutional because Brazil’s Constitution provides that the social security system is to be financed by the entire society. Excluding some nonresident individuals while making others contribute based only on the location of the employer would not be fair or constitutional, Lula da Silva said.
Argentina’s ambassador in Brazil criticized the watered-down ZPE law, saying it is another anomaly in Brazil’s industrial policy that will have a negative effect on any attempt by Mercosur to create a decent customs union, one of Mercosur’s main goals.
Paulo Skaf, president of São Paulo’s Industry Federation, Brazil’s most powerful industry union, said the Industry Federation opposes ZPEs because they are no longer necessary. ZPEs were proposed in the mid-1990s when the country was desperately seeking foreign investment and hard currency. But with appreciation of the Brazilian currency of almost 15 percent in relation to the U.S. dollar in 2007 alone, it is clear that the country needs no further incentive to bring hard currency into the country, Skaf said. Further appreciation of the Brazilian currency would only harm industry and the economy, as Brazilian products would become less competitive in international markets, he said.
Sources in the executive branch said Lula da Silva will issue a provisional measure to regulate some vetoed measures, including some vetoed tax breaks.
David Roberto R. Soares da Silva